Observation TD Economics www.td.com/economics January 18, 2011 HIGHLIGHTS OUTSIDE OF MORTGAGES, U.S. CREDIT SHOWING BROAD IMPROVEMENT • Underlying the improvement in The U.S. economic recovery has picked up steam over the last several months. economic indicators over the The recent momentum in economic indicators, in combination with another round last several months has been of fiscal stimulus, has led many forecasters – ourselves included – to upgrade the growing signs that the econo- my is also seeing a recovery in outlook for real GDP growth over the next year. credit conditions. In a recovery punctuated by a credit crisis, unleashing economic potential will • The mortgage market continues require an improvement in credit growth. While the credit crisis began in the U.S. to act as the major constraint housing market, the credit freeze that took place in its aftermath affected all sectors on growth, but outside of mort- of the economy. In combination with broad losses in wealth, the increased cost of gages, credit availability, credit credit and reduced availability for businesses and households contributed to the quality, and credit growth all depth and severity of the economic recession and the insufficient pace of recovery. appear to have turned a corner. However, as we move further away from the financial crisis, there are growing • Commercial banks’ willingness signs that credit markets are on the mend. While residential and commercial real to lend to households and mortgage lending con- businesses has moved from tinues to be constrained, BANKS TIGHTENING C&I* tightening to easing. LOANS TO BUSINESSES outside of mortgages, Net-percentage • Loan delinquencies for con- credit availability, cred- 100 Tightening sumer loans and commercial it quality, and credit 80 and industrial loans fell consis- growth are all showing 60 Large Firms tently through 2010. broad improvement. Small Firms • Led by gains in non-revolv- This trend bears watch- 40 ing loans, consumer credit ing. As the minutes of 20 growth, which represents 18% the Federal Open Mar- 0 of total household liabilities, ket Committee (FOMC) has turned positive in recent -20 months. Correcting for charge- meeting in December Easing offs, consumer credit growth is noted: “an acceleration -40 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 accelerating. [in economic growth] *Commercial and industrial • Faster credit expansion means would likely be accom- Source: Federal Reserve Senior Loan Officer Survey more money creation and re- panied by significantly duced risk of deflation. more rapid growth in bank lending and in monetary aggregates.” Given the type of • While the recovery in credit is recession and recovery we have experienced, an increase in credit may even lead still in its early stages, a further the move to higher economic growth. acceleration of credit growth What is more, the current weakness in real estate is less a matter of continued could signal a move to a much deterioration of mortgage quality, and more a legacy of past credit excesses. Reduc- stronger pace of economic ing uncertainty about the value of real estate assets and the eventual losses faced growth than currently expected by lenders will depend on the pace of growth in the broader economy. Should the by markets or forecasters. improved pace of credit growth outside of real-estate markets accelerate, it could signal a move to a much stronger economic growth trajectory. James Marple Credit availability is improving Senior Economist First on the list of encouraging signs is that the credit freeze is thawing and 416-982-2557 becoming more available. A key source of information with respect to the availabil- firstname.lastname@example.org ity of credit is the Senior Loan Officer Survey conducted quarterly by the Federal Observation TD Economics January 18, 2011 2 www.td.com/economics COMMERCIAL BANKS REPORTING INCREASED even before the overall delinquency rate began showing im- WILLINGNESS TO LEND TO CONSUMERS provement, there was a growing divergence in credit quality Net percent amongst different loan types. In particular, loans secured by 80 real estate have seen delinquency rates remain high, while 60 More willing unsecured loans to consumers and businesses have been on a 40 steady downward trend since 2009. The delinquency rate on 20 consumer loans, including credit cards, peaked in the second 0 quarter of 2009 at 4.9% and as of the third quarter of 2010 -20 had fallen to 4.1%. Similarly, after peaking at 4.4% in the -40 Less willing fourth quarter of 2009, the delinquency rate on commercial -60 and industrial loans reached 3.3%. -80 The improvement in credit quality is important because -100 1980 1985 1990 1995 2000 2005 2010 it could mark the beginning of a virtuous cycle where bet- Source: Federal Reserve Senior Loan Officer Survey, Haver Analytics ter credit quality leads to more credit growth and improved economic growth, which in turn feeds back into greater credit quality. Reserve. The most recent survey for the fourth quarter of 2010 was conducted in October and revealed that outside Consumer credit growth is accelerating of residential mortgages, willingness to lend to consumers While understandably much of the focus over the reces- and businesses continues to move in the right direction. On sion has been on the decline in mortgage credit, unsecured net, commercial banks are easing standards on consumer consumer credit is an important component of household credit cards and other loans, as well as on commercial and borrowing, representing close to 18% of total household industrial loans for both small and large firms. As shown in liabilities. After decades of gains in consumer credit – fu- the chart above, willingness to lend to consumers is at its eled by strong growth in credit card debt – consumer credit highest level in over five years. plunged during the recession. From its peak, total consumer Delinquency rates are falling credit fell by 7.3%, led by a 17.2% decline in revolving credit (credit cards), and a 1.3% decline in non-revolving credit. The trends taking place in credit standards are also mir- The change in consumer credit outstanding reflects both rored in credit quality. Delinquency rates saw a meteoric the write-down of non-performing loans as well as the rise for nearly all types of debt over the recession. The total change in credit due to consumer behavior – households commercial bank delinquency rate for all loans and leases taking on less debt or paying down debt. The main reason peaked in the first quarter of 2010 and after remaining steady for the decline in consumer credit over the recession was due in the second quarter, fell in the third quarter. Nonetheless, COMMERCIAL BANK DELINQUENCY RATES COMMERCIAL BANK CHARGE-OFF RATES Percent Percent 12 8 Real Estate Loans 7 Real Estate Loans 10 Consumer Loans 6 Consumer Loans 8 Commercial & Industrial Loans Commercial & Industrial Loans 5 6 4 3 4 2 2 1 0 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: Federal Reserve Source: Federal Reserve Observation TD Economics January 18, 2011 3 www.td.com/economics CONSUMER CREDIT CONSUMER CREDIT Year-over-year % change Annualized quarter-over-quarter percent change 20 30 15 20 10 10 5 0 0 Revolving Credit Consumer Credit Adjusted for Charge Offs* -10 -5 Non-revolving Credit Consumer Credit -10 -20 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: Federal Reserve Board. *Calculation by TD Economics Source: Federal Reserve to the former – a large increase in the charge-off rate. While basis, revolving consumer credit was slightly negative in data on charge-offs for the entire economy is not available, early 2010 – a new phenomenon for credit cards – while data is available for commercial banks, which represent just non-revolving net credit issuance slowed, but did not actu- under half of total consumer credit. Charge-offs on consumer ally contract. credit rose to a peak of 6.7% in the second quarter of 2010, Importantly, over the last several months, there has been led by credit cards, which rose to 10.9% – the highest level a considerable improvement in consumer credit growth. for which data is available going back to 1985. Even with the impact of charge-offs, total consumer credit As shown in the chart below, by removing the decline rose in both October and November – the first two consecu- in consumer credit due to charge-offs, we get a picture of tive monthly gains since June and July of 2008. Moreover, the change in credit issuance. While this is only an estimate the weakness in consumer credit growth is concentrated without data for the non-commercial bank sector, given the within credit cards. Non-revolving credit has seen fairly importance of commercial banks in consumer credit, it is strong growth, rising by an average of 5.1% (annualized) likely a good representation of broader trends. Correcting over the past five months. This turn from negative to for charge-offs shows that household deleveraging did positive growth is particularly important for a variable like lead to a slowdown in credit issuance. On a year-over-year consumer credit, which exhibits a lot of momentum. Look- ing at the history of consumer credit, positive growth tends to be followed by more positive growth (and vice versa). CONSUMER CREDIT ADUSTED The fact that consumer credit growth has moved back into FOR CHARGE-OFFS* positive territory is a good signal that it will continue to Year-over-year % change 30 grow in the months and quarters ahead. 25 Revolving Credit More credit means more money Non-revolving Credit 20 An increase in the pace of credit growth is significant 15 because it relates directly to the transmission of monetary 10 policy to the broader economy – lower interest rates only 5 stimulate growth if they result in an expansion of credit. 0 But, it is also important because of what it means for the -5 expansion of the money supply. With a fractional reserve -10 banking system, money creation depends on the creation of 1986 1990 1994 1998 2002 2006 2010 new loans, which result in new deposits, which in turn result *Estimate by TD Economics based on commercial bank charge-off in new loans – a process called the multiplier effect. So, rate. Source: Federal Reserve, TD Economics the fact that credit growth appears to be expanding should Observation TD Economics January 18, 2011 4 www.td.com/economics MONEY SUPPLY RESIDENTIAL MORTGAGE DELINQUENCIES Year-over-year % change Percent of total loans 20.0 6 17.5 M2 30 days past due 5 60 days past due 15.0 M1 90+ days past due 12.5 4 10.0 7.5 3 5.0 2 2.5 0.0 1 -2.5 0 -5.0 1980 1984 1988 1992 1996 2000 2004 2008 2006 2007 2008 2009 2010 2011 Source: Federal Reserve, Bureau of Economic Analysis Source: Mortgage Banker's Association, Moody's Economy.com also show up in a faster pace of money supply growth. Problems in mortgage market reflect legacy of past Looking at the aggregate money supply data – both M1, bad loans which includes just currency and checking deposits, and Perhaps the only mitigating factor in an otherwise good M2, which also includes saving and time deposits – this is news story is the lack of traction within real estate secured exactly what we see. On a year-over-year basis, weekly data lending. However, while the delinquency rate on residential for M2 shows a growth rate of 4.0%, a steady acceleration and commercial mortgages has remained high, this does from its trough (at 1.0%) in March. not mean that there has not been an improvement in the Given fears about deflation, the nascent rise in money mortgage market. Indeed, for residential mortgages, the supply growth is an important development. Inflation is percent of mortgages entering delinquency (that is, falling essentially a monetary phenomenon – create enough (ag- behind 30 days on their payments) also peaked in mid- gregate) money and prices will rise. While the significant 2009, as did the 60+ delinquency rate. Consequently, there amount of economic slack is likely to keep a lid on price is a much smaller pipeline for future seriously delinquent pressures over the next year, the increase in money supply mortgages. The outstanding issue in residential mortgages growth, which is only likely to accelerate further under the is the backlog of mortgages that are 90 days or more past Federal Reserve’s asset purchase program, eases signifi- due on their payments, but have not made their way through cantly the risk of a deflationary spiral. the foreclosure process. While data for commercial real estate is harder to come by, what is available for commercial mortgage backed se- U.S. HOUSEHOLD ASSETS & LIABILITIES curities, suggests the same phenomenon is also at play for 20 Year-over-year % change non-residential mortgages. In both cases, problems moving seriously delinquent mortgages through the foreclosure 15 pipeline and into liquidation are the main reasons for still 10 heightened delinquency rates. Until there is more progress 5 on resolving delinquent mortgages, secured lending is likely 0 to remain impaired. As we discuss in our report, Resolving -5 U.S. Housing Problem Essential To Avoiding Japan Expe- Assets Liabilities rience, without a resolution in housing, improvement in -10 other sectors of the economy can only push the gas pedal -15 down so far. At the same time, the fact that credit quality -20 is improving outside of mortgages illustrates that resolving 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 issues in housing and commercial real estate could lead to a Source: Federal Reserve Flow of Funds much faster pace of credit expansion and economic growth. Observation TD Economics January 18, 2011 5 www.td.com/economics Bottom Line With interest rates at record lows and pent-up demand The U.S. economic recovery is becoming more firmly still present, the further along that U.S. households move in entrenched. As the economy moves further away from the terms of repairing their tattered balance sheets, the greater financial crisis, the balance of risks in terms of economic the potential for spending to rise. While the deleveraging activity must also reflect the potential for growth to surprise process is likely not yet complete and the U.S. saving rate to the upside. Perhaps the best early signal that upside is likely to remain elevated, stronger income growth will economic risks may be gaining prevalance is the condition allow consumer spending growth to match. Moreover, as of credit markets. Given the importance of the supply and expectations improve, greater wealth creation prospects demand of credit to the Great Recession and recovery, an will allow for upside to spending alongside further balance improvment credit growth could be the best sign that the sheet repair. The improvement in credit conditions is still economy has moved into a virtuous cycle based on higher in its early stages and the housing market is still rife with expectations for future demand that lead to greater invest- uncertainty, but there is certainly cause for optimism in the ment and production today. direction of changes over the last several months. This report is provided by TD Economics for customers of TD Bank Group. It is for information purposes only and may not be appropriate for other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysis and views, including about future economic and financial markets performance. 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